Richard Green is a professor in the Sol Price School of Public Policy and the Marshall School of Business at the University of Southern California.
This blog will feature commentary on the current state of housing, commercial real estate, mortgage finance, and urban development around the world. It may also at times have ruminations about graduate business education.

Thursday, January 10, 2013

Economists and the public are both right about free trade

"Free trade" is the one issue on which economists - at least, American economists - famously agree. And yet, substantial majorities of Americans think that free trade has hurt them. In the Zingales paper, trade was the issue where there was the greatest divergence between economists and the public. How can the common people disagree so sharply with the overwhelming expert consensus? Are the common people simply a bunch of flat-earthers who refuse to look at the evidence? Or do they have a point?

The workhorse model of trade is the Heckscher-Olin model. The model predicts that trade leads to higher output for the countries that trade. I actually think that this is hard to dispute. But the model also predicts that when a country opens up trade, its scarcer factor of production winds up worse off. In the case of a capital intensive country like the United States, Heckscher-Olin predicts that returns to capital will rise and returns to labor will fall. The return to capital rising is greater than the return to labor falling, so the size of the pie increases. Nevertheless, without redistribution, trade makes labor (particularly unskilled labor) in the US worse off.When the US was going through the process of trade liberalization, workers were promised that the damage imposed on them would be mitigated by Trade Adjustment Assistance. To say that the program is too small to be effective is an understatement. The only way to effectively offset the harm done to workers via trade is with redistribution that leaves workers at least as well off as they were before trade liberalization. Note that such redistribution would still leave owners of capital better off than they would be in the absence of liberalized trade.I continue to have the view that on balance open trade is a good thing--among other things, it almost certainly reduces the probability of war breaking out, and this is pretty valuable in and of itself. But when many Americans think trade has made them worse off, they are not being unreasonable.

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